How to Come Clean on Delinquent Foreign Bank Account Filings

A Comparison of Options

March 2014

In the last several years the IRS has increased enforcement of the reporting of foreign (non-U.S.) financial accounts and their related incomes. The IRS has provided serious motivation for taxpayers holding foreign accounts to file by using the threat of wildly high penalties and the potential for criminal prosecution. Starting July 1, 2014, FATCA – the Foreign Account Tax Compliance Act – requires “foreign financial institutions” to review their accounts and report those with ties to the United States. Foreign banks, hedge funds, some precious metals companies, and even some life insurance companies are all subject to the new law. Under the threat of huge financial penalties, Uncle Sam is making foreign bankers become the eyes and ears of the IRS. Even now, with the threat of penalties and criminal charges and the existence of worldwide information reporting of US foreign financial account holders, many taxpayers continue to underreport income or assets held in offshore financial accounts. Through the past few years, the IRS has provided many options for delinquent filers to come into compliance; today, three of those programs still exist.

History

The requirement to file a Report of Foreign Bank and Financial Accounts (“FBAR”) has existed since the Bank Secrecy Act of 1970. Since that time, any US person with a financial interest in or signature authority over foreign accounts with an aggregate value exceeding $10,000 at any point during the calendar year has been required to file an FBAR. Until 2004, penalties and enforcement for delinquency in filing FBARs were virtually unseen. In 2004, Congress increased the penalties “without regard to willfulness” for the failure to file an FBAR.

Today we have FinCEN Form 114 (formerly Form TD F 90-22.1) for taxpayers meeting the filing requirements. This form must be received by the Department of the Treasury by June 30th of the year immediately following the reportable calendar year. The maximum penalty imposed on delinquent filers is the greater of $100,000 or 50% of the highest historical balance in each account with the potential for criminal prosecution. If the IRS believes the failure to file was non-willful, they may reduce the penalty to $10,000, and if they believe there was “reasonable cause” for failure to file, the penalty can be eliminated.

Options for Delinquent Filers

There are four options that currently exist for US taxpayers with delinquent FBARs and unreported foreign income to come into compliance:

The IRS Streamlined Filing Compliance Procedures

The 2012 Offshore Voluntary Disclosure Program (“OVDP”)

The Traditional Voluntary Disclosure Program

Filing in lieu of protection (also known as a “quiet disclosure” filing)

The first three of these options are open-ended federal programs, which have specific requirements and their own strengths and weaknesses. The fourth option has no specific requirements and the potential for greater reward (no penalty) but leaves the taxpayer entirely at the mercy of the IRS.

Option 1: Streamlined Filing Compliance Procedures

The eligibility for filing under this option is very fact specific. This option is only available to non-US resident taxpayers who have resided abroad since January 1, 2009 and have not filed US tax returns during that period. Also, the US tax liability for each year being filed must be less than $1,500, and each return must be filed with a valid Individual Taxpayer Identification Number (“ITIN”) or Social Security Number. If the filer meets the above requirements he/she must submit:

Income tax returns and related informational returns for the past 3 years

The benefit to filing in this manner is that the taxpayer may be able to entirely avoid any penalties related to their delinquent foreign filings. If the taxpayer presents a high compliance risk, there is still the potential for IRS scrutiny and penalties. The more complex the taxpayer’s situation, the more they might want to consider Option 2.

Option 2: Offshore Voluntary Disclosure Program

This option is available to all US taxpayers (resident and non-resident) but has stricter and more requirements. To file under this program’s protection the taxpayer must first contact the IRS Criminal Investigation Lead Development Center to request pre-clearance and then submit an Offshore Voluntary Disclosure Letter.

The IRS will review the Offshore Voluntary Disclosure Letter and determine if the taxpayer is accepted into the program. If accepted, the taxpayer will need to submit a full Voluntary Disclosure Package, which will include original or amended tax returns and information returns (including FBARs) for the past eight years prior to the disclosure, as well as payment for back-taxes, interest and penalties. All submission requirements can be found here at the IRS website.

The benefit to filing under this program is the applicable penalty will be capped at 27.5% of value versus the maximum 50%. The cap can be further reduced to 12.5% if the account balances were consistently below $75,000, or even to 5% in some limited circumstances.

Option 3: Traditional Voluntary Disclosure Program

This voluntary disclosure program (Traditional VDP) has been in place for decades. The IRS has a longstanding internal practice to consider “voluntary disclosure,” along with other factors, in determining whether criminal prosecution will be recommended. Although there is no guarantee, voluntary disclosure may generally result in prosecution not being recommended. The requirements for a Traditional VDP include a “voluntary disclosure which means a truthful, timely, and complete communication, when:

Taxpayer shows a willingness to cooperate with the IRS in determining his/her tax liability, and

The taxpayer makes good faith arrangements to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.”

Unlike options 1 and 2, there are a lot of unknowns about the traditional VDP. Guidance that is offered in the form of FAQs for Options 1 and 2 is not offered for Option 3.

Option 4: Filing in Lieu of Protection (also known as “Quiet Disclosure” filing)

The major weaknesses of Options 1 & 2 are: under Option 1, the eligibility requirements are very restricted and Option 2 basically guarantees the payment of a penalty, albeit less than the maximum. Under Option 3, there simply are no parameters addressing how the IRS will act to resolve the case, and the final outcome depends on IRS whimsy. There is a fourth option available that may appeal primarily to taxpayers who are not eligible for Option 1 (i.e. US Residents) and have simpler returns and smaller foreign account balances.

All the taxpayer must do under this option is file the required FBARs and attach a statement asserting reasonable cause for each delinquent tax year. A taxpayer may also have to amend income tax returns if there was unreported income from the foreign accounts. The crux of this option lies in the taxpayer’s ability to assert “reasonable cause” for failing to file their FBARs. This is not entirely helped by the fact that filing in lieu of OVDP protection leaves the taxpayer subject to IRS discretion and interview(s) by the IRS Criminal Investigation Division. If the taxpayers can successfully establish a reasonable cause, there will be no penalty, but they do run the risk of the IRS rejecting their reasonable cause assertions and assessing a penalty larger than those applicable in the OVDP program.

Conclusion

Taxpayers who still are delinquent in filing their FBARs have a few options available to them to come into compliance while potentially avoiding large penalties. The choice of option is extremely dependent on the specifics of each taxpayer’s situation. Taxpayers are highly encouraged to seek the help of a tax professional to assist in this decision-making process.

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